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Nortel: Financial Stuff Really Complex

Nortel Networks Ltd. (NYSE/Toronto: NT) today said there would be further delays to its internal audit and restatement of earnings; and the company released more details about its financials, including the fact that $250 million in revenue reported in 2000 will be "permanently reversed."

Nortel's stock traded down 6.7 percent, losing US$0.24 to $3.34. Nortel has already repeatedly delayed its filing, frustating many investors. Others may have been spooked by the size of the numbers released by Nortel today.

"Rev of US$250M from 2000 will be permanently reversed and another $2.25B will be shifted forward to 2001-2003," wrote UBS AG analyst Nikos Theodosopoulos in a research note issued today. "This implies that in 2000, the height of the tech bubble, revenue was distorted by $2.5B or 9%."

Theodosopoulos is maintaining a Neutral rating on the stock with a $3.60 target price.

With the announcement, Nortel appears to be pushing the limit of the patience of its shareholders. Since revealing an accounting scandal and becoming the target of a Securities and Exchange Commission (SEC) investigation last spring, Nortel's accounting restatement, first expected in July, has now dragged on for about half a year (see Nortel Misses Halloween Target).

The statement, released today by president and CEO Bill Owens, struck an almost sheepish tone, as if to say, "Sorry guys, but this is really hard."

Nortel has scores of people working to unravel the accounting mess, and Owen went to great pains to justify the delays by the complexity of the project.

"The challenges of reviewing and verifying hundreds of thousands of documents and communications and related accounting entries over multiple fiscal periods have been monumental," says Owens in the statement. "We have dedicated every possible resource to completing the restatement, including the continued commitment of many hundreds of finance personnel and more than 200 personnel from a number of outside consultants and advisers."

Nortel told Light Reading in September that the combined number of folks working on its accounting, including the 200 outsiders, was about 650 people (see Nortel Restates Delay of Restatement ).

Today's statement included the most detail to date that Nortel has released on the project. Nortel now expects "low single digit" growth in 2004. These growth targets have been slipping since the company's frequent updates first started appearing last summer. Nortel's balance sheet appears to be stable, however, as Nortel says it expects to report $3.4 billion in cash at the end of September 30. That's down slightly from the $3.7 billion it reported in cash during the comparable quarter of 2003, but the company notes that there has been "no material effect" on its cash position through the restatement.

But wait, there's more!

Nortel also released the latest details of what is going on under the covers, including specifics about which revenues were overstated and by how much. The full details can be read about in the news release, which is here.

Here are those details:

  • Nortel says that based on work done to date, it has identified adjustments to revenues, primarily in the company's Optical Networks and Enterprise Networks businesses that have resulted in a net reduction in revenue of approximately $600 million and $2.5 billion in 1999 and 2000, respectively.

    Of the amount in 2000, approximately $250 million of revenue will be permanently reversed, says Nortel, with the remaining revenue adjustments in 1999 and 2000 being deferred and recognized in subsequent years.

    Nortel says that overall, these adjustments resulted in net decreases in revenue in 2001 and 2002 and a net increase in revenue in 2003.

  • Moving the revenue adjustments from 1999 and 2000 into subsequent years will result in a net increase in revenues of approximately $1.35 billion, $450 million, and $450 million in 2001, 2002, and 2003, respectively, according to the company. This will also result in additional deferred revenue on the balance sheet as of December 31, 2003.
  • The earnings hit may be less than expected. Nortel now says it expects a reduction of net earnings of approximately 35 percent in 2003. That's adjusted from the 50 percent hit that it had previously announced. Nortel also says there will be "a reduction in previously reported net losses for such periods including 2002 and 2001."

  • Nortel said it's in the middle of hashing out some details for the accounting of embedded software with the SEC. At issue is the GAAP of revenues recognized on sales of certain optical products containing embedded software. Nortel says that its accounting treatment of these products is appropriate and says it has the support of external auditors.

So what's next? Nortel says it's setting up a new "timeline," for the final stages of the restatement. It expects to file full financials for 2003 "within 30 to 60 days." [Ed. note: What are the Vegas odds on that?] It plans to release "limited preliminary unaudited results for the third quarter of 2004 by mid December 2004."

"As soon as practicable thereafter," Nortel expects to file its unaudited financial statements for the third quarter of 2004, and related periodic reports and any required amendments to periodic reports for prior periods.

The big question now, however, is how much investors practicably will believe.

— R. Scott Raynovich, U.S. Editor, Light Reading

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dljvjbsl 12/5/2012 | 1:05:34 AM
re: Nortel: Financial Stuff Really Complex The article states that Nortel has indicated that the earings restatement will ave no material effect on their cash position. This is something that has puzzled me about the type of bookkeeping that seems to exist in the high tech industry.

Cash seems like a simple enough concept to define. it would be the money Nortel has in the bank and other securities. It is difficult to see how this could be affected by the analysis of transactions that took place two and three years ago. However I have noticed that compnaies state that their cash position can depend on the accounting standards that they adopt. This indicates to me that accounts do not have to be a true picture of a company's financial position.

Can somebody with knowedge of accounting standards clarify this.
William Wallace 12/5/2012 | 1:05:34 AM
re: Nortel: Financial Stuff Really Complex these adjustments have to affect market share as well...somehow - anyone have any insight into this? - NT leads DWDM globally for metro and LH - not too shabby in SONET either - wonder if those some positions based on these fiscal events?
straightup 12/5/2012 | 1:05:32 AM
re: Nortel: Financial Stuff Really Complex As a project manager, it's a little hard to accept that when a project that a project spanning close to year, you can miss you current target finish date by 30-60 days when it you updated it just 3 weeks ago!

I can't help feeling that modern leadership is to tell people what they want to hear (which is how Nortel got into this mess in the first place!)

"The trouble with normal is it always gets worse" -- Bruce Cockburn
boozon 12/5/2012 | 1:05:19 AM
re: Nortel: Financial Stuff Really Complex take the cash and run...
exnortel2 12/5/2012 | 1:05:17 AM
re: Nortel: Financial Stuff Really Complex If NT booked over 3 billion as revenue for the years 1999 and 2000, which it must reallocate to subsequent years, will this lead to criminal investigations/charges against the CEO and his top lietenants during 1999 and 2000.

I know I will not recover my NT holdings in my retirement portfolio. But those who mislead investors should face legal consequences.
dljvjbsl 12/5/2012 | 1:05:16 AM
re: Nortel: Financial Stuff Really Complex The New York Stock Exchange has warned Nortel that it shares will be delised if the revenue and earnings restatement is not relased by December 15th
chook0 12/5/2012 | 1:05:14 AM
re: Nortel: Financial Stuff Really Complex Depends if it was wilful/deliberate or not. In the hierarchy of evildoings,

1. diddling earnings is/was commonplace and I suspect still practiced by some unnamed companies who always seem to beat the street by a penny. It can be done by all kinds of "reasonable" decisions about when to take charges, reverse provisions, etc. Up until now that was all that Nortel was suspected of.

2. diddling revenue used to be fairly common but definitely wrong and frowned upon. You can do that by loading trucks headed for the channel at 10pm on the last day of the quarter and taking the gear back as a stock rotation the next week. These days Sarbanes Oxley has made clear a lot of grey areas on revenue recognition and raised the stakes a lot with respect to fiddling. Only practiced by the brave/foolhardy/desperate these days. However, revenue recognition is full of difficult calls still. (when has an order become "unlikely to be reversed"?) Note that in many cases you can have the cash in your hot little hands and still not be able to recognise it as revenue - for example if the transaction is still contingent on delivery of some new feature and the gear can come heading back for a refund if it doesn't materialise.

Fiddling revenue can definitely send people to people to jail in theory.

3. Fiddling cash is definitely evil and people should go to jail. Pretty hard to say you made a mistake about cash.

--Chook.
inauniversefarfaraway 12/5/2012 | 1:05:14 AM
re: Nortel: Financial Stuff Really Complex Investors and the markets are finally getting a taste of the real Nortel. Ask any employee, or former employee, and you will quickly get a sense of what working for this company can be. The similarity with what investors are experiencing is chilling.

It would seem that employees are constantly subjected to this type of mismanagement. That is to say: management saying one thing, but then doing another, or saying they will do something, and never delivering, or always putting off, until concerned employees leave, or forget all about the issues.

Even employees that deliver on time are rejected by a culture of stupidity and arrogance. Their successes are quickly publicized by management that takes credit. Now, there are even fewer people wanting to risk actually producing anything. What is left?

It seems that in it's evolution, Nortel has finally rid itself of any productive element, and has fully embraced ignorance. This is after all, much easier than reform. When you think about it, by having more people in on the scam, they buy the silence of the majority. Who would dare being singled out?

It is striking that in thousands of years of religious and social development, we have failed in many ways still. While we repeat and are taught from childhood elementary values, we continually repeat fundamental errors of judgement when it really comes down to it. By this I mean specifically the lapse in the basics. We all know that Barabas was set free, while someone else bore the weight of all our sins. Maybe there is a more fundamental lesson on human nature than we ever thought. Maybe there is something to this that says more about all of us than we dare examine.

Perhaps it is time we ask ourselves why it is that we single out whistle blowers? How is it possible that people like Roth, and Dunn are rewarded with millions of dollars, while the poor fools that built the products that made them rich are looking for employment?

Do you think that Roth, Dunn, or Owens, can play the violin in a similar manner as Nero?

This is the biggest challenge facing society. The next time you worship, think about how the "majority" has set the crooks free only to condemn those who would bring truth, or deliver substance.

The reality is that it is the few that deliver, but it is the majority that benefits. It is therefore more probable that a random individual will find allies in the corrupt majority than in the productive minority since ineptitude is more universal than brillance.

Our societies aren't very bright if they continously repeat the sins it examines with fervor every day, every week.

That is the real challenge. No doubt that any company can turn things around, as with any society. But without fundamentally sound values rewarding the positive elements in any segments of society, these experiments will only add to the missed lessons of history.

There is a 99.999% chance that none of the people involved in this farce will ever see the inside of a cell, because: this is the way, this is Nortel.

The certainty is that letting them off the hook will guarantee the outcome. They will fail at their own hands. Their history will be just another bad memory.

They can add Nortel beside the Avro Arrow, eh?
telecomzar 12/5/2012 | 1:05:13 AM
re: Nortel: Financial Stuff Really Complex I can share some brief thoughts on the situation.
There were three types of people working for NT over the years. The techies, the smarts, and the crooks. Once everyone figured out that broadband growth projections were a scam the ship started to sink. The interesting part is that most everyone understood this. Any employee could have told you that the company was a colossal disaster in 1999. Even when revenue was growing. Underneath the perception of greatness everyone felt disengaged from reality. My guess is less than 5% of NTer's could actually tell you where all the revenue was actually coming from. This brings me back to the three types of people theory. First, the techies were so involved with developing 80 wavelengths of OC-192 that they had no idea they were actually running the ship ever faster into the perfect storm. The smarts were so busy trying to implicate the crooks that they couldn't focus on the real issue of managing. And finally, the crooks were focused solely on getting rid of the smarts, for fear of being implicated in obvious chicanery. It's important for people to understand that NT is not a business. NT is an organization of people who make technical products and as a consequence some sell.
dljvjbsl 12/5/2012 | 1:05:09 AM
re: Nortel: Financial Stuff Really Complex To the person who made the link between Nortel and the Avro Arrow, your comparison is most apt. In both cases Canada ahd the possibility of creating something that was truly great. In both cases, Canada failed and the failure seems to be linked to things that are basic to the Canadian character.

Why strive for greatness when mediocrity is so easy?
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